Archives for July 2019

Powell’s Arrogance & Ignorance to Continue – Here Comes the Cut

What to Expect Today

Let’s get the worst kept secret out of the way. The FOMC is going to cut interest rates today by 1/4%. I don’t know of anyone who doesn’t believe that short-term rates are going down today, regardless of whether they agree or not. The big question is going to be what Powell says after that. Is this an “insurance” cut as in one and done? Or, is it the beginning of a rate cut cycle like we saw in 2007 and 2001? The last two cutting cycles began with 1/2% cuts and as we know, ended very poorly for the economy and especially the financial markets. I would be very surprised if the Fed cut by 1/2% today and frankly, a little more than concerned. Today’s cut is most similar to July 1995 when stocks were also at or close to all-time highs, but the economy then was stronger and inflation and unemployment were much higher.

Model for the Day

As with every Fed statement day, 90% of the time stocks stay in a plus or minus .50% range until 2pm before the fireworks take place. I fully expect that to be the case today. Besides that, there is also a strong long-term trend for stocks to close the day higher, although that is not as strong as it used to be. Additionally, with stocks near all-time highs and significant upside progress over the past two months, the bulls have even less dry powder than normal.

Given Apple’s earnings beat last night and other positive reports, I can certainly make the case that the easy money will be made from last night’s close to 10:00 am today. Finally, although not conforming to any special Fed day trend, I am certainly aware that any short-term rally may be sold, either from Jay Powell’s comments or just routine, sell the news, profit taking.

Jay Powell’s Arrogance & Ignorance

As I already mentioned, everyone knows what the Fed is going to do at 2:00 pm today. That’s not in debate. And right now, the market is pricing in at least another two rate cuts. Long time readers know that I have been very critical of the Fed, more with Yellen and Powell than Bernanke although Big Ben did make perhaps the single greatest imbecilic comment in 2007 when he said the sub prime mortgage crisis was “contained” and there would be “no contagion”. It would be impossible to have been any more wrong than that and on an epic scale.

Anyway, I think the Jay Powell led Fed is among the worst groups since 1988 when I entered the business. Greenspan may have been the worst Fed chair since Arthur Burns in the 1970s but Powell is certainly working on his legacy and it’s not an enviable one.

For 6 years I have pounded the table that raising interest rates AND selling assets which is now being referred to as quantitative tightening is the mistake of all mistakes. Selling assets is akin to also hiking rates as it reduces liquidity and tightens financial conditions. Janet Yellen should have chosen one or the other. Pick your poison. Instead, she forged ahead with both.

Jay Powell continued on that path except he, in a grand stroke of additional arrogance, decided that rates should go up at a quicker pace. Arrogance and ignorance are among the two worst character traits and I think Powell has them both. We all saw what happened last December when the Fed added that one additional rate hike and did not temper the asset sales. The global financial markets collapsed like hadn’t been seen since the Great Depression.

The Fed – Savior of the Financial Markets

Now, you can argue that it’s not the Fed’s job to appease the financial markets and you would technically be correct. The Fed has a dual mandate from Congress. Price stability (inflation) and maximum employment. However, the Fed, for the most part, usually follows what the markets want and have priced in. I say “usually” because there have been a few times when the Fed has gone off book.

Remember, the Fed doesn’t want to upset the financial markets. These markets are absolutely vital the U.S. and global economies. And despite what you may hear from Lizzie Warren and Bernie Sanders, a healthy and vibrant Wall Street community is an absolute necessity to a growing economy, even though that same group is prone to bouts of greed and bad behavior which can have a periodic and significant detrimental impact on the economy (see chapter on how the financial crisis began in 2007 and 1929).

When politicians from both sides talk about how Wall Street “wrecked” the economy, they always forget how many direct and indirect jobs were created from Wall Street’s work. The problem is that we (the U.S.) always seems to reward bad behavior and don’t punish it. And so many politicians continue to pat themselves on the back for the Dodd-Frank piece of legislation which did good by increasing capital standards but failed miserably by declaring victory that the days of Wall Street bailouts were over. Not a chance.

When push comes to shove, the political will is never there to let a Morgan Stanley or a Goldman potentially take down the economy with out. In real time in 2008, my thesis was that AIG should not have been saved which would have sent Goldman down with it. I thought letting more institutions be punished would have caused more short-term pain, but the free market would picked up the slack and the economy would have seen a much, much better recovery than it did., A topic for a different day.

Dual Mandate

As I already mentioned above, the fed has a dual mandate from Congress. Regardless of what President Trump believes or wants, the Fed’s instructions are from Congress. When we look at the Fed’s dual mandate, Congress essentially directs the Fed to keep inflation manageable and seek to have the country fully employed.

Right now, unemployment is at or near record lows with minority unemployment also at or near the lowest levels since records began. That is maximum employment, a point where the Fed would normally worry about a labor shortage and a spike in wages. While wages are finally rising, we are not seeing a squeeze and nothing like McDonalds paying signing bonuses like we saw years ago. With half of the Fed’s mandate pointing towards a rate hike, it’s makes me wonder.

Looking at price stability (inflation), we see the same trend that has been in place for more than a decade; inflation cannot seem to get going. While many people are familiar with the Consumer Price Index, the chart below is a much better gauge and you can Google if you want more info about it. The blue line excludes food and energy and this CENTURY you can’t find a single year of 3%. The very random Fed target of 2% has barely been met since the financial crisis.

So, the second half of the dual mandate is certainly amenable to a rate cut. You have the dual mandate at odds. In my world, that would mean a neutral stance by the Fed. Leave rates unchanged and stop selling assets. Let things be for now.

Jay Powell & Company at Odds.

Jay Powell and the majority of the voting members of the Fed want to cut interest rates by 1/4% or 1/2%. There is a minority faction that wants to leave rates alone. Powell has spoken about an “insurance” rate cut. He discussed weakening economies in Europe and Asia that eventually could impact the U.S. I just want to know where in the dual mandate it says that the Fed should worry about China and Europe. The rest of the world is now seeking to loosen financial conditions so now Powell wants to follow them.

The markets are expecting 1/4% cut. One of the many great charts and work that Tom McClellan does has to do with forecasting a rate move based on the two-year Treasury Note. Below is a chart of that instrument overlayed with the Federal Funds Rate which is the actual interest rate the Fed controls. Tom argues that all the Fed needs to do is follow the two-year Note instead of meeting and debating all the time. His analysis certainly has merit.

When the solid black line is below the colored line, the Fed is allowing easy financial conditions. The reverse is true when it’s above the colored line. Right now, the two-year Note (the market) is telling the Fed to cut rates. While I believe it’s premature, the market does not.

What I Would Do

While I could go on and on and on as I sometimes tend to do, I am going to wrap this up by saying that Powell is going to hide behind tariffs and China as the reason to cut rates today. Although I absolutely do not think he will intend to poke the President, I do think that labeling tariffs as the potential economic weakness culprit will certainly tweak Donald Trump.

My own economic forecast remains unchanged since I first offered it in late 2017. I think the U.S. will experience a very mild recession beginning before the 2020 election. Although there are so many doom and gloomers who forecast something much more ominous, it’s almost impossible with the banks in such great shape, literally sitting on more than two trillion dollars in cash. And if you want to know what I would do instead of cutting rates, I would stop paying the banks to keep their excess reserves at the Fed. This would force them put some money to work in the economy.

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Big Week Ahead

Boy, it only took a single day of weakness, Thursday, for bulls to get right back to work. Friday made quick work of the bears and the bulls look like they are not quite done yet. Of course, the Fed will have a lot to say about that when they conclude their two day meeting on Wednesday with an almost certainty for fireworks. More on that in another update.

The government released Q2 GDP and it can be interpreted two ways. First, it came in at 2.1%. That is not a strong number in a vacuum. However, analysts were expecting something just shy of 2% so the number beat expectations. I was looking for a number that began with “2” so it was right on from my seat. The President was all up in arms that had not been for Jay Powell and the Fed, GDP would have printed a “3” number. While that all sounds quaint, there is no way to prove or disprove that notion. Trump has been doing a great job of antagonizing the Fed and turning them into villains. You know my read. They are not competent enough to be a villain.

Friday’s nice rally in all major indices but the Dow had little to do with the GDP report. Tech was solid but semis took a breather. Banks were strong yet again. Discretionary and transports were average. Junk bonds have been digesting for almost two months and they seem to be percolating for another move higher. The NYSE A/D Line just keeps plowing higher to more fresh all-time highs.

The headwinds I discussed last week in Lots of Ammo for the Bears remain in place. And if you only read the headline which some people apparently did, you totally missed the theme of the post. I was absolutely not taking the bearish case. Quite the contrary.

With earnings and the Fed, this week should be a high profile one with some volatility.

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Lots of Sideways Action – Could Lead to Another Leg Higher

With tech earnings season in peak mode, we are seeing huge moves in the prominent companies like Amazon, Google and Facebook, but overall, the indices have been relatively calm. The Dow and S&P 500 have been range bound and the longer this sideways action continues, the more likely the ultimate resolution will be to the upside.

Bears have been pointing to the poor action in the S&P 400 and Russell 2000. The problem is that they have been behaving poorly for some time and their laggard state is not a good timing tool for when it might matter. Additionally, we saw both mid and small caps jump sharply relative to the other indices on Wednesday. Perhaps this is nothing more than a blip, but if it becomes sustainable, that would give a nice boost to the stock market.

As I keep writing about, semis have really turned from goat to hero over the past 6 weeks, but really this month. They are very, very stretched and extended at this point. Some pullback is expected. The longer they can go without giving too much of the gains back, the more likely another leg higher is coming. Banks have woken up to follow their diversified financials cousin and while I don’t think they will become market leader anytime soon, they could certainly give the overall market a boost if they got going to the upside, something that hasn’t happened in a long time.

Finally, junk bonds have been consolidating for most of July and they keep percolating. This is yet another group where time is wearing off the overbought condition and could lead to another leg higher later this quarter if all goes right.

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Lots of Ammo for the Bears

Lots of focus on technology this week as some of the behemoths report earnings. One thing is certain; there will be movement. All of the major stock market indices ended last week on the defensive as the bears put the plow down with a very heavy selling wave last Friday afternoon. That resulted in hundreds of stocks closing lower from all-time or recent highs which a yet another sign of a tired market. Coupled with overly confident options traders and very bullish sentiment surveys, the consolidation/pullback continues. The longer the bulls can keep prices from declining, the more likely the ultimate resolution will be strongly to the upside.

I find it really interesting here that there are certainly enough things to warrant a deep pullback but price, the final arbiter, has held up remarkably well. Momentum has been that strong, so far. And let’s not forget that the calendar isn’t exactly a pillar of strength for another few months. The bears have a good deal of ammunition and if they can’t get going sooner than later, we may just get that melt up to Dow 30,000 as I have been discussing longer than any analyst, pundit or clown.

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Opening Gaps the Theme – Financials Leading Banks

As earnings remain the theme over the next few weeks, large gaps on the up and downside at the open can be seen as the more impactful companies report after the close of the previous day. After Wednesday’s close tech giant Netflix delivered a very poor earnings report that looked to weigh very heavily on Thursdays open. However, by morning, those losses were somewhat mitigated and a only a mildly lower open should be seen. After Thursday afternoon’s tech slide, perhaps the bulls will make a little stand.

Price patterns in the Dow, S&P 500 and NASDAQ 100 are now more indicative of a pullback or at least some sideways consolidation than an unabated continuation of the rally. Over the past week or two, we have seen sentiment surveys and option traders show a little too much greed, meaning that they are feeling a little too giddy about the stock market. Typically, after a sizable rally, that can cause some pause or giveback. I certainly do not believe a significant decline is underway nor a bear market.

I continued to be heartened by the recent strength in the semis as well as discretionary. If the banks can get going like the diversified financials have been, we could see another leg higher in stocks during summer. It’s been very interesting to see the banks going sideways while the financials have been so strong. Below, you can see the two groups, banks followed by financials.

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Earnings Season is Here – Internals Fairly Strong

With earnings season beginning in earnest this week, the markets are now focused on two major items, earnings and the Fed. Weaker than expected earnings will give the Fed another excuse to cut rates at the end of July, not that they are really looking for more reasons to cut. With stocks at all-time highs, expectations are now very high for companies to deliver this month. Those that don’t will be severely punished. Sentiment has also become very bullish with the recent move to new highs so any pullback would not be unexpected.

Looking at the major indices, we still have the same issues. While the Dow, S&P 500 and NASDAQ 100 are at new highs, the S&P 400 and Russell 2000 remain well below those levels. The divergent behavior isn’t so much a concern in the right here and now, but if it persists, it can lead to challenges for stocks. On the sector front, semis have stepped up and I do believe they will see all-time highs later this quarter. Discretionary continues to make fresh highs. Transports and banks remain in their ranges and the stock market really needs one to get into gear if we are going to see that run much higher.

Participation in the rally has and is strong. The NYSE A/D Line continues to make new high after new high, behavior not typically seen at the end of bull markets. High yields bonds have pulled back very nicely and constructively although sentiment has certainly soured this month. I don’t think they have seen any kind of peak of significance just yet. Rather, this pullback should end sooner than later and lead to another leg higher in junk bonds.

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Trump 1 – Powell 0

Fed Chair Jay Powell finished his second day of testimony on Capitol Hill and his comments were unambiguous regarding a rate cut. It’s coming and it will not be a one and done. When pressed about the very strong employment landscape, he basically dismissed it and focused on everything his mandate doesn’t include, like weakness in Europe and trade tensions. I couldn’t find those listed in the Fed’s dual mandate of price stability and maximum employment. Um, ah, the economy has full employment. Interesting times we live in. Yes indeed. If you’re keeping score of the Trump/Powell battle, it’s Trump 1, Powell 0.

Stocks continue to drift or creep higher in an unconvincing fashion. On Thursday, the Dow was up almost 1% but the S&P 500 advanced barely .20%. The NASDAQ was even and the mid and small caps were down .25% to .50%, not exactly textbook behavior for the bulls. All four key sector were higher, but junk bonds were not. The same number of stocks rose as declined. While the stock market does look a little tired, it’s very hard to pick any top, let alone this one. Usually, creeper rallies last longer than anyone imagines, but gives back all of those gains very quickly when the tide turns.

My issues up here are that I am no longer in love with stocks like I was in December and January. I turned negative on treasury bonds last week and I have been pushing against gold for a few weeks.It’s no fun being the party pooper, but the risk/reward is not favorable. And if the stock market breaks out convincingly, I will play the chase game very quickly to add to my exposure.

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Powell on the Hot Seat

Wednesday is yet another one of those media created “all-important” days this month as Fed Chair Jay Powell begins two days of testimony before Congress in what used to be called the Humphrey-Hawkins testimony named after the two Congressmen who created the act. With stocks at or near all-time highs the only precedent for an interest rate like the market is expecting at the end of the month is July 6, 1995 when stocks were also at or near all-time highs.

It’s definitely strange that with rates so close to 0%, the markets are craving more easing. Inflation is the big driver and contrary to what so many pundits predicted over and over again as the Fed was printing $4 trillion, inflation hasn’t been anything close to worrisome in more than 10 years. Europe is weak. So is China. The U.S. is softening, but certainly not weak. Beginning an interest cutting cycle with full employment and almost 200,000 new jobs a month can either be viewed as “insurance”, risky or the Fed seeing something alarming. Given the Fed’s perfect track record of never, ever accurately forecasting recession, we can all but rule out the last one.

I am eagerly awaiting the Q&A session after Powell’s opening statement which will be released well in advance of his arrival on The Hill. No doubt, President Trump’s public criticism will be questioned along with Powell’s view on whether he can be fired or demoted. Don’t expect Powell to engage.

Markets remain the same from my view. Price action, which I deemed as incomplete to the upside, should look much more complete after today, although that has nothing to do with the impetus for a decline. The NYSE A/D Line continues to score new highs and high yield bonds act well. Large declines do not begin with this set up. On the negative side, mid and small caps aren’t close to all-time highs. Sector leadership is not strong as only discretionary is at or close to new highs.

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Don’t Go to The Hamptons – Big Move Coming

With the world seemingly focused on Friday’s employment report, I expected a lot more fireworks than we saw. After a gap lower at the opening and some modest follow through, stocks made it all the way back to even before tailing off to end the day. I have been talking about the rally not looking “complete” yet and that is starting to change. Our models remain defensive and only a break above Dow 27.000 on a daily and weekly close with conviction and strong internals will cause a rethink.

Semis have pulled back very nicely and orderly. They are supposed to rally from here. Failure to do so would be a change of character and warning that something is amiss. Banks remain in a range and can only be seen as neutral here. The death of the consumer has been exaggerated for more than a decade, yet discretionary just powers ahead in a leadership position. Transports are at an inflection point. A close above last week’s high should send them on a run and provide some fuel for the stock market to move higher. A move modestly lower could unleash a summer selling wave of more than 10% which would almost certainly spillover into the rest of the stock market.

Overall, sector leadership from my four key sectors doesn’t appear to be all that powerful right here. This seems like one summer to stay tuned and not hang out in The Hamptons!

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Rally Not Complete Even Though New Highs Waning

Stocks continue the traditional holiday week drift higher. The S&P 500 has made fresh all-time highs and I expect the Dow and NASDAQ 100 to follow suit very shortly. The S&P 400 and Russell 2000 may take some time. While I continue to be a little defensive on stocks over the short-term, some of the indicators within our models that caused that in the first place have strengthened. I imagine the next week or so will be key to see how things like advancing and declining volume behave along with where stocks close each day relative to their range.

One thing I have been commenting about on Twitter is that stocks the rally in stocks still does not seem complete. There are certain price configurations which I look for and I mentioned a some a few weeks ago. The rally has been orderly and well behaved and missing the usual ingredients of ending. We will see what Friday brings with the June employment report and last big piece of data before the FOMC meets at the end of June to decide on cutting interest rates.

One negative that it not factored into our models but making the rounds this week is the number of stocks making new 52 week highs. Below you can see the S&P 500 in the top chart and the number of new highs on a daily basis on the bottom chart.

A few weeks ago, you can see the line spiked to over 300, but now sits below 200 as stocks keep slowly marching higher. That’s your typical non confirmation or divergence. Not all of these are negatives and this is one case where I think it’s much ado about nothing.

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